PhotoMedex: Just say No!No!

PhotoMedex (NASDAQ:PHMD) is stirring up a cauldron of characters and events that makes this “no!no!” hair-removal device company a hair-raising proposition for investors.

Characters include Kim Kardashian, the competition’s formerly raven-haired spokeswoman who was sued by PHMD.

And there’s Lewis Pell, board chairman and angel investor whose battered wings reportedly contributed to an initial public offering falling apart. Before he and Shlomo Ben-Haim both wound up at PHMD, he sued Mr. Ben-Haim, his frequent business partner and friend, alleging unfair distribution of assets.

Finally, insider Mr. Ben-Haim is an oft-sued Israeli biotech gentleman billionaire whose enemies once labeled a thug. His rival in one of those lawsuits is none less than the State of Israel, which alleged he and a partner stole Israel’s technology for freezing cells and entire organs.

Here are six key PHMD issues that we believe pose risks for investors:

Now, through the light of a full moon - and TheStreetSweeper’s digging - investors can get a good look at ominous scars that may well damage the company’s future stock price.

Frankensteinian beginnings

PHMD was just barely whistling past the graveyard, even considering a bankruptcy filing in the summer of 2009. Losses exceeded $10 million and a new money deal from private investors had collapsed for the Montgomeryville, Pa. company.

Staring down the throat of insolvency and a management shakeup, PHMD was anything but a reasonable IPO candidate. While competitor Tria Beauty exercised the good sense to back out of a planned initial public offering last year, not so with PHMD.

In fact, just months after the U.S. Securities and Exchange Commission warned investors about risks related to reverse mergers - see the link here - the bedraggled PHMD completed its reverse merger in December 2011.

So the roughly $174 millionIsraeli reverse merger allowed PHMD to pull its foot out of the grave. It added Radiancy products to its portfolio - particularly the home-use hair remover plus other dermatological devices - to PHMD’s products for dermatologists for use on skin conditions such as psoriasis.

This company’s new leader would be Dolev Rafaeli, formerly Radiancy’s CEO. Radiancy shareholders wound up with about 75 percent of the combined company and PHMD shareholders got the rest.

The company still conducts research and development and parts of other critical operations in Hod HaSharon Israel, where Radiancy began in 1998. PHMD’s filings note investors’ risk inherent in this situation, including the possibility of employees being pulled from reserve to active military duty.

“We cannot assure you that ongoing hostilities related to Israel will not have a material adverse effect on its business or our share price,” its filing states.

More on point for investors, the exchange rate may pose a financial risk since much of the company’s operating expenses are conducted through New Israeli Shekel currency, according to filings.

The merger satiated PHMD. But then came a foot-dragging revenue drop to $58 million for the second quarter, a fall below both the company’s guidance and analysts’ best bets. We think this is a frightful trend destined to trick unwary investors.

Thugs, withdrawn IPO and alleged misappropriated funds

Mr. Pell and Dr. Ben-Haim have added to their personal wealth while this partnership has built a tumultuous history around Radiancy.

In 2004, Radiancy - a company described by EuroWeek as “slightly eccentric,” as witnessed by a mission statement featuring quotes from the Yoda character in Star Wars - was on the verge of offering public shares on the London Stock Exchange. Then infighting reportedly broke out, chiefly, among Mr. Pell, Dr. Ben-Haim and company founders.

By the time the dust settled, Radiancy had buried its IPO and company founders filed suit alleging Mr. Pell and Dr. Ben-Haim used thuggish methods to try to grab their share of the company.

“The company's locks were changed, and the security company's ‘thugs’ were ordered not to let the plaintiffs into the building,” plaintiffs contended before the parties were able to settle the lawsuit.

Mr. Pell, a vintner and restaurateur, was already well acquainted with strife - in the late 1970s he got permanently barred from working in any capacity for any registered brokerage firm.

The New York Stock Exchange imposed the penalty after Mr. Pell pleaded guilty to charges related to misappropriating customer funds and securities by having securities transferred to a different customer’s account. The link is here.

Despite previous issues, Dr. Ben-Haim and Mr. Pell reunited at PHMD under the leadership of new CEO Rafaeli.

Mr. Pell, who serves as PHMD board chairman, and business partner Dr. Ben-Haim each became majority stockholders in the merged company, racking up about 1.8 million shares of PHMD apiece as of June 11, worth almost $28 million at about $15.40 per share.

Clinical study: No!no! no more effective

One of the biggest issues that could ultimately upset investors revolves around PHMD’s biggest product. It’s a hot-wire device designed to burn the hair and damage the hair follicle - similar to laser, light devices - or epilation which a medical doctor described to TheStreetSweeper as a small wire that delivers heat into a single hair follicle, that thermally destroys or damages the follicle so the hair doesn’t grow or can’t be seen.

PHMD also makes products for psoriasis and other skin disorders sold to dermatologists, aestheticians and consumers. But its top product is the no!no! device designed for longterm hair removal in the home.

But it just doesn’t work any better than shaving.

That’s right. Vanderbilt University Medical Center clinical assistant professor Dr. Brian Biesman conducted an eye-opening study, including a statistical analysis of hair counts on 22 test subjects who used no!no!. Subjects shaved an area of a leg with a razor blade and an adjacent area of the leg with the no!no! device.

Even longterm the no!no! was no more effective than shaving, Dr. Biesman said in an interview with TheStreetSweeper.

“Our study found it was comparable to shaving. It was no better and no worse in terms of the number of hairs in the treated area, the color of the hair and the thickness of hair,” said Biesman, Nashville Center for Laser and Facial Surgery director and past president of the American Society for Laser Medicine and Surgery.

The medical journal “Lasers in Surgery and Medicine” published the study. Sponsored by Tria Beauty, the study underwent peer review among experts who disclosed no conflict of interest. Dr. Biesman said he got feedback from experts who endorsed the study methodology.

Dr. Biesman said nurses performed the study treatments. Though some consumers have reported no!no! burned them, test subjects had no such problems.

As for long-term hair removal effectiveness “... it seems unlikely that, if 16 treatments produce no effect whatsoever, 24 or 48 or some other number would deliver the profound results claimed by the manufacturer,” Dr. Biesman wrote in the report published in July 2013.

PHMD’s odd studies

Even the studies PHMD uses on its own web site contain some rather spooky revelations.

“Adverse events were limited to mild erythema with crusting” in three of the 12 subjects who completed the study, plus another one whose erythema and crusting were severe enough to cause the person to withdraw, according to a 2007 study published in the Journal of Drugs in Dermatology.

Apparently, instead of smooth, cover-girl legs, 30 percent of subjects were plagued with quite the opposite - a crusty rash.

Unlike the other two studies listed on PHMD’s web site, at least this one appears to be published in a peer-reviewed journal and discloses that Radiancy funded the research. In our opinion, this is the only study of much substance released by PHMD.

Unfortunately, though, study subjects tried only no!no! so there was no control or alternative treatment studied. Unlike the typical study, results were simply compared to other studies on laser hair removal adverse effects.

Results also show that no!no! got rid of just 48 percent of leg hair initially and 43.5 percent at 12 weeks. The bikini area fared worse at 5 percent and 15 percent.

The study compared results from other studies on long-pulsed laser and ruby laser use. But results appear meaningless because the no!no! was not tested in the same areas - lips, necks, chins and armpits.

PHMD also includes a third study paper that apparently was not published in a peer-reviewed scientific publication and appears to lack the conventional statement of funding. It’s peculiar that it contains a large photo of the no!no! product at the bottom of the study, looking for all the world like an advertisement.

Also, results showed a rather disappointing 27 percent cut in hair count after one week, then about 45 percent at 28 weeks. So, even after about seven months, subjects still were stuck with more than half-way hairy legs.

All three studies are interesting but simply lack the data to tell us that the no!no! actually works, said Dr. Theresa Pacheco, a physician and associate professor in the dermatology department at the University of Colorado Anschutz Medical Campus.

“Dr. Brian Biesman’s study is much more detailed and objective and published in a peer-reviewed journal, which means that other hair experts vetted this study before publication,” she added. She has no conflict of interest and no connections to PHMD, Tria or Dr. Biesman.

Dr. Pacheco said in an email that the US Food and Drug Administration doesn’t require in-depth studies for hair removal devices to enter the market place and be sold to consumers. So the company is taking the path of least resistance.

Dr. Pacheco added that consumers should seek expert advice to find the best solutions among many treatments ranging from bleaching and prescription products like Vaniqa to various shaving/waving type methods to home devices like Tria’s Silk’n flash lamp to professional laser/light based devices.

“The no!no! device per Dr. Biesman’s study,” she said, “did not remove hair or reduce or delay hair regrowth when compared to shaving.”

Consumer complaints

Some consumers report disappointing results, too, even saying they have been burned by no!no!, though we admit these could have been caused by a malfunctioning unit or misuse. Online reviews noted troubles included stinky hair, burned hair, more luxuriant hair, clueless customer service reps and difficulty getting money refunded.

Here are a few samples:

Under the title “False advertisement, ineffective product,” a consumer wrote that her calls requesting a refund kept getting disconnected:

“I was sucked in and bought your completely ineffective product ... I tried it for a 2 wks and it does NOT WORK ON thick, coarse African-American hair, despite (their) false advertisements to the contrary.”

Here’s another one from Amazon.com, where nearly 61 percent of no!no! ratings were one star: “When my hair started growing back it was thicker and more abundant than before. You can only imagine the stress!”

I would highly recommend NOT TO BUY THIS PRODUCT - DOESN'T WORK AND CAN'T GET A REFUND!!!”

And another one reported a painful experience:

“The infomercial claims the NoNo is painless. I can tell you from first hand experience that this is an outright lie. It feels like having a curling iron pressed against your skin. It even left a few burn marks on my sister in-law's arms!... I personally will be sticking with my razor and shaving gel; its a lot less expensive, doesn't burn me, doesn't leave me stinking, and actually works.”

Burns were reported by another consumer: “But to top if it off (were) the permanent scars that I received from this product. I have to use makeup now to cover the scars from the burns on my face. I want to sue this company...”

And here’s another recent comment:

“I was dumb enough to buy the nono, it was a BIG waste of a lot of money. It does not work ...”

Negativeno!no! ratings on Amazon virtually exploded, with one star and two star ratings hitting the 408 mark, compared with a puny 45 ratings of four to five stars.

Though negative reviews overwhelmed positive ones on site after site, a mixture of negative and positive comments are available here.

According to the Better Business Bureau, Radiancy or no!no! have closed 313 complaints over three years. The BBB also included this statement: This firm has misrepresented itself as a BBB Accredited Business on its Web site at www.trynono.com . On July 27, 2011, the BBB requested that this firm cease and desist all unauthorized use of the BBB name and logo on its website. On August 3, 2011, the logos have been removed.

Finally, Dee Fahey, who says she is a registered nurse with a cosmetic therapy/electrolysis license, described product questions from her clients:

“Some phrase their questions in a way that says, if electrolysis doesn't work, then I may try No No. It should be the other way around. I invite them to try NoNo and then tell them I will wait for their phone call asking for an electrolysis appointment because No No didn't work.”

As for consumers’ expectations, the voice-over for no!no! TV commercials say, “Imagine never having to shave again.” They don’t say thatthese roughly $270-$300 devices will eliminate shaving.

Ms. Kardashian and looming legal issues

Los Angeles TV celeb and fashion designer Kim Kardashian’s lawsuit involving Radiancy isn’t quite as dramatic as her much-watched, much-tweeted love life. But she adds some Kardashian punch to what could have been a boring lawsuit.

Competitor Tria Beauty filed suit against Radiancy the year before the PHMD merger, alleging false advertising and trademark infringement by the maker of the at-home hair remover and acne treatment. Radiancy countersued, claiming false advertising for Tria hair and acne products.

Radiancy added Ms. Kardashian as a defendant in November 2011 in the counterclaim, contending she made false and misleading statements in media appearances and Twitter messages as Tria spokeswoman. Radiancy sought unspecified damages in claims that she used the product on her “entire body,” though Tria’s hair removal laser wasn’t cleared for use on the face and head.

Though that litigation and its roughly $5.6 million settlement cost is behind PHMD, other false advertising issues could involve a potential class action suit.

A demand letter in November 2011 by Milstein Adelman LLP, followed by a similar one from another company, alleges Radiancy violated California law in marketing and advertising its no!no! hair removal device. Furthermore, the Milstein letter requests restitution for a class of consumers due to alleged violations of California’s unfair competition, false advertising, health and safety laws. Of course, the uncertain timing and outcome loom large.

Main product peaking?

The future of PHMD’s no!no! is also uncertain, we believe.

In an August 2011 filing, PHMD listed Germany as one of its main international markets.

Analysts at Maxim noted in June 2012 that the vast majority of consumer segment revenue came from North America and Japan, with expected help from Germany.

“We expect a similar growth profile from the company’s planned geographic expansion in Germany and Korea ....” Maxim added that summer.

Similar musings continued four times this year, with Brazil added to the wish list. Maxim began to sound frustrated enough with the delays that it adjusted estimates in August.

“To account for the more gradual entry into Brazil, and the slower than expected ramp in Germany ... we are reducing our 3Q13 and 2013 revenue estimates to $58.5M and $234.6M, from $66.0M and $248.4M,” Maxim analysts wrote Aug. 8, 2013.

The next day, PHMD execs said during the earnings call that the Germany launch had finally made it to the early stage and was able to generate only about $1 million.

“Germany, all the early signs gives us a lot of reason to be optimistic about that. In Brazil, the news that we published so far in the quarter included finalizing the acquisition of the company down there that gives us presence in the local market. The comment we made earlier that we are expecting launch in the second half with pushing for the third quarter but definitely in the fourth quarter, we’re still on that pathway,” said Dennis McGrath, president and chief financial officer.

Most of PHMD’s sales are made in America, which provided 72 percent of total revenue last quarter and in Japan, which accounted for 16 percent from its sole distributor there, according to filings.

Yet PHMD contends it’s looking for more growth in Japan. We believe PHMD overstates the prospects for no!no! there.

Why? Hair removal probably isn’t a huge concern in Japan, one might extrapolate from a Nagoya University School of Medicine study of more than 600 women. University researchers’ clinical assessment determined a lower level of body hair among the Japanese .

Meanwhile, we think PHMD also may be seeing its key U.S. market product peaking.

To keep sales up, PHMD is busy spending millions running no!no! ads on everything from short commercials on broadcast stations to hour-long infomercials on cable to the web to Plus-TV commercials shown on JetBlue Airways flights. Execs recently said PHMD backed off on some no!no! product direct-to-consumer marketing in North America because cost per media increased.

The 2Q direct-to-consumer revenue fell to $30.3 million from $33.7 million for the prior year. Yet the overall media buying and advertising expenses rose to 27.5 percent of revenue in 2Q from 25.7 percent the prior year.

So the company’s blowing through a higher percentage of ad dollars to sell the products.

Insider selling precedes huge buyback

If selling signifies lack of confidence in the company, as we believe it does, PHMD must suffer from an inferiority complex.

Insiders have gone on a huge selling spree since October 2012, especially CEO Rafaeli. He owned nearly 2 million shares as of June 11, 2013. But he’s shaved those shares in trust down to about 966,700 in a short time, records show.

Rafaeli’s selling has been a point of contention among analysts. The following exchange occurred during the last earnings call.

Unidentified Analyst: "Okay. And the other frustration that I want to share is Dolev, you have been selling a lot of stock lately and so I am just trying to understand your reasoning for that and how ... your expectations are with the company shareholders?"

Rafaeli: "I am not sure how deep you would like me to go into this but this is a 10b51 plan that was filed in June of 2012. I am not selling the shares, the trustee does and I am sure they do this according to the plan."

Director Katsumi Oneda alsotrimmedroughly 1.5 million shares down to a million, while President McGrath chopped his shares from about 323,000 to about 200,000, records indicate.

We submit that this selling indicates what’s wrong with the stock buybacks - another $30 million repurchase is planned this year. The company appears to be using shareholders’ cash to benefit just a few select insiders from whom stock is bought. We think it helps rich insiders rather than smaller investors as large investors buy blocks sold by insiders.

Key consumer segment: falling revenue

Consumer sales fell to $48.7 million in 2Q, a .8 percent sequential decline but a more concerning 3.5 percent drop from the year before.

Execs inexplicably blamed the drop on the Boston Marathon shootings and the Oklahoma tornadoes.

Blaming shootings and the weather for a sales drop is a stretch of monstrous proportions. But TheStreetSweeper believes the more likely explanation is that PHMD’s top product, no!no!, is losing popularity in its key location of the U.S. and could continue to decline.

Here are three related financial factors that support the point.

* First, PHMD had to pour nearly $2 million extra into selling, general and administrative in 2Q. That’s a chunk of change, especially since the company’s most popular category still dropped behind the same quarter the previous year.

* Second, direct-to-consumer sales not only plummeted compared with the prior year 2Q, it also dropped 4.4 percent sequentially, too.

* Third, consumer revenue the year before increased 19.6 percent from 1Q to 2Q ($42.2 million v. $50.5 million). This compares with the comparative revenue decline to $48.7 million already notedin the same time period this year.

Adding to this witch’s brew of financials, consumer revenue historically dropped 23 percent and 7 percent sequentially in the last quarters of 2011 and 2012 - so this increases the chances of disappointing numbers boiling up in coming quarters. Even normally optimistic analysts are expecting a slight (more than 1 percent) sequential fall.

Analysts’ annoyance with PHMD came out loud and clear during the last earnings call.

“...2013 was supposed to be a growth year and it’s now looking like it’s going to be a flattish revenue kind of performance,” said an unidentified analyst. “... so all those frustrations here, the stock it hasn’t performed at all. And I’m just trying to figure out if there was a misstep at all on your end as far as assuming what kind of expectations we should have?”

President McGrath responded in part that the history is that before it jumps, “this business moves sideways for a quarter or two ...”

Investors will want to pay attention to history, too, and look back at the two earnings misses in 2012 (1Q 26 cents v. First Call’s expected 28 cents; 2Q 20 cents v. 30 cents). Even though analysts have cut back their estimates for next quarter to 32 cents, the signs suggest another earnings miss could be lurking.

So it's time to throw on the garlic necklaces. We believe a bag full of issues could haunt investors well beyond the Halloween season.

* Important Disclosure: The owners of TheStreetSweeper hold a short position in PHMD and stand to profit on any future declines in the stock price.

Editor's Note: As a matter of policy, TheStreetSweeper prohibits members of its editorial team from taking financial positions in the companies that they cover. To contact Sonya Colberg, the author of this story, please send an email to scolberg@thestreetsweeper.org.